Speed up foreclosures to stabilize the market, an ODU researcher says

NORFOLK — The faster foreclosures happen, the better it might be for the real estate market, a study from Old Dominion University suggests.

Two researchers used modeling and simulation to examine the lingering impact of foreclosures.

Michael J. Seiler, professor of finance, and Robert M. Stanton, endowed chair of real estate and economic development, teamed with Andy Collins, an assistant professor at ODU's Virginia Modeling, Analysis and Simulation Center (VMASC). Seiler recently presented the research at the Massachusetts Institute of Technology.

They used a model of 2,500 homes to predict how a slew of homeowners defaulting on their mortgages would affect other homeowners not in default. Some owners are deciding to default, even if they have the financial wherewithal to pay. That's called a strategic default.

"The neighbor who is paying the mortgage finds out about their neighbor who isn't, and it creates something called the moral hazard problem," Seiler said. "The paying neighbor asks himself why he should continue paying his mortgage when his neighbor stopped paying a year ago and nothing bad has happened to him. It creates an incentive for people to do a bad behavior, one that's harmful to others in the market. This problem is quickly getting out of control and someone needs to step in."

Seiler likened it to taking off a Band-Aid. It hurts to pull it off quickly, but then it's over. Pulling it off slowly lengthens the pain.

This flies in the face of government programs to slow or stop the foreclosure process and keep people in their homes.

It may sound heartless to speed up the foreclosure process. Though it puts a family out of their home, it protects the rest of the neighborhood, and the overall real estate market, from further price declines, Seiler said.

The cure for the spread of this foreclosure "disease," he said, is for the market to stabilize. The longer it goes before it stabilizing, the more people it puts in danger of defaulting, he said.

The perception of foreclosure has changed. In the 1960s, a strategic default was "like a scarlet letter on your chest that you would hide," he said.

"Now, it's not only socially OK, some people actually brag about it," he said.

They use the "it's not my fault" argument. They say they were tricked into a loan by someone who knew they couldn't afford it. They pass the blame to the lender, Seiler said.

That's evident when in some cases foreclosed families have spray painted profanities on their walls aimed at the banks, Seiler said.

By walking away from their mortgage, "I think they're justifying their behavior based on a retaliation, based on the way they perceived — sometimes accurately, sometimes inaccurately — how they were treated," Seiler said.

Media coverage of the foreclosure wave isn't helping the real estate market. National media tend to focus on hot spots, leaving an inaccurate picture of the local market. Some markets have been scarred deeply by foreclosures, while others have been lightly affected.

That leaves buyers expecting to get 40 percent off prices here, when that's not the case, Seiler said.

"It creates a disconnect between expectations and reality. The homebuyers are frustrated. They keep thinking, 'Why am I not getting the deals I hear are out there?'" he said. "Because we're in such a 24/7, national media focus, we think that it is the national market."

Another factor depressing the real estate market and keeping it from clearing out the surplus of homes for sale is that homes are worth less than what people bought them for, Seiler said. Many people can't afford to sell their home because they don't have cash to close the deal.

People need a way to get out from under investments they should not be in. He suggests that banks could approve a sale for less than the amount owed and finance the deficiency over time for the former owners, who shouldn't have been allowed to buy the house in the first place.

"If the bank doesn't allow them to do that, this person's going to say, 'Forget it, then. I'm just going to stop paying you all together.' The bank is just not willing to bend at all. With them unwilling to bend, I don't see them getting their money," Seiler said.

What's stopping banks from doing this, he thinks, is that banks fear too many people will take them up on the offer — even those who can afford to keep making their payments.

"I know that there's a fear. But with all the billions of dollars the government is throwing at the problem, I don't see why this can't be one of the potential solutions," he said.